Amazon was one of the first companies to pioneer this new business growth model. Since then it has been followed by many companies, including Netflix, Facebook, Twitter, Uber, Movie Pass, etc.
So what is this model? Does it really work? And most importantly, what does it all mean to you?
Let’s find out.
What Is New Business Growth Model?
The model focuses on growing network at all costs, including profitability.
Some people refer to it as Grow Big Fast or as Mark Zuckerberg of Facebook famously said “Move fast and break things”.
In the simplest terms, the model focuses on company valuations based on the potential future earnings, not the current ones.
This future earning concept draws in the venture capital. The venture capitalists bank on the possibility that the company will make a lot of profit at some point in the future. The theory is that the company will move fast, capturing market share, destroying the competition by under-pricing them. In the process, the company will likely burn through cash to achieve this objective.
The company cannibalizes its competition as quickly as possible. The focus here is to make it impossible to compete with them.
Because this strategy is very expensive, the company requires multiple rounds of funding. They used the raised funds for salaries, operation, and discounting. The discounting happens so that the company can monopolize the market and gain momentum with brand recognition through marketing.
What Happens Next?
When a sufficient market share is gained and just about everyone knows their name, they go public.
In this stage, the risk is transferred from a few private investors to the public at large.
Because the company valuations are based on what’s possible to earn with the market cap (users, followers, etc.) they are valued in billions of dollars.
In actuality, if you were to look under the hood and investigate further, you could find that the company is not profitable. Instead, it is losing money and is predicted to lose into the unforeseeable future. It’s right there in their model.
While the company must undergo certain regulations once public, the scrutiny is much looser when the company is private and even in the pre-IPO (initial public offering). Even though there are much stricter regulations for a company trading publicly (as oppose to the one held privately), the company does not have to guarantee profitability.
Why Does That Matter To You?
Due to the lack of financial education, the average stock owner doesn’t even know where to look and evaluate the company. Instead, they focus on what’s in the news and buy based on the “recommendations” they get from media or their friends. They focus on the stock price going up and not the underlying fundamentals.
What has been happening is that the public is buying a stock because the name is familiar, even though the owner of such shares cannot explain how the company makes money or whether they are even profitable.
The new phenomenon is that mutual funds are riding the wave of the stock price rise and buying shares of these companies.
So even if you wouldn’t but these stocks yourself, most Americans are invested in those. This mostly happens through their 401k, as they are in nearly all mainstream mutual funds. And mutual funds are pretty much the only thing you can buy through your employer sponsored retirement funds.
Why Does My Company Sponsor These?
Sometimes it is because the individuals making decisions to sponsor these, do not have a complete understanding. Often, they focus on the sales pitch which typically lands with a whole lot of numbers, charts, graphs, and a smile. The sales person is often not knowledgeable either and they say exactly what the parent company tells them to say. Basically they read or memorize a script.
The sales person is only focused on one things: making the sale, so that they and their family can eat, keep a domicile, and pay their bills.
Many, although not all, companies get kickbacks from the mutual fund companies.
It becomes a partnership to offer their product in their corporate retirement plans. Sometimes these are set up on a fixed payment basis and others on a per number of employees enrolled.
This could mean additional income for the business. And thee company gets this, regardless whether you make money through those investments.
Most companies and the administration want you to make money, as they too, are often invested in those products. If you do well, they do well. But they cannot control which direction the investment will go.
Why Does The Stock Price Go Up?
The stock price goes up when there are more buyers than sellers. This is a basic supply-demand concept that explains many things in economics.
To raise the price, the company has to ensure that more shares are bought than they are sold.
With corporate buybacks companies are purchasing their own shares of stock which boost the price. The owner sells their personal shares for huge profits (remember their shares were priced at a few cents when the idea of the company was born).
Based on the company valuation (mostly made up) and the numbers of shares held the media reports on the “wealth” of the owner/CEO.
What’s The Big Deal?
The big deal is that no company (or person) can forever be unprofitable.
Try it in your own personal life. Run the expenses to be ten times your earnings and see how long you can last. If you have a capability to borrow a lot of money, you may have a larger runway. But eventually you will run out of money and will have to pay those loans back.
As long as individuals are prepared to shell their money towards these companies, they will continue to thrive. However, the moment that a large purchaser decides to sell or people catch on and stop buying into something that only makes money with more people joining in (sound familiar???) the company fails and investors lose money.
I am not saying that the companies named above are not profitable. I have used them only as an example of the new business model, so that you can go back and look how it starts. Most people are not familiar with how this works. Therefore, I wanted to ensure you look at what you’re buying and why before you buy.
Whose Job Is To Invest Well?
It is your responsibility to investigate what you invest your money in. You need to know what you are actually buying, when you buy a mutual fund. At the end of the day, all of the investments you make are your responsibility.
After all, it is your money and NO ONE, absolutely NO ONE, cares about your money and what it does more than you do! Or at least they shouldn’t.
Want to learn to invest better? Interested to start and grow your own business? Check out our On Demand Courses.